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January 2020
CEE
Quarterly
Macro Research
Strategy Research
Credit Research
CEE: An outperformer
in testing times
1Q2020January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
“Your Leading Banking Partner in
”
Central and Eastern Europe
UniCredit Research page 2 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
Contents
4 CEE: An outperformer in testing times
17 CEE Strategy: Dancing to the tune of the US credit cycle
24 Acronyms and abbreviations used in the CEE Quarterly
COUNTRIES
26 Bulgaria: Fiscal impulse in 2020 is likely to be only moderate
30 Croatia: Straight line to ERM II entry
34 Czechia: A two-speed economy
38 Hungary: Outlook shaped by external risks
42 Poland: Domestic resilience
46 Romania: Damage control
50 Slovakia: External and political uncertainty
52 Slovenia: Growth likely to slow further
EU CANDITATES AND OTHER COUNTRIES
54 Bosnia and Herzegovina: Growth slows reflecting weaker external demand
56 North Macedonia: Focus on external headwinds and politics
58 Russia: Recovery postponed to 2021
62 Serbia: External headwinds take center stage
66 Turkey: The pace of recovery is unlikely to impress
Erik F. Nielsen, Group Chief Economist (UniCredit Bank, London)
+44 207 826-1765, erik.nielsen@unicredit.eu
Dan Bucşa, Chief CEE Economist (UniCredit Bank, London)
+44 207 826-7954, dan.bucsa@unicredit.eu
Artem Arkhipov, Head of Macroeconomic Analysis and Research Russia (UniCredit Russia)
+7 495 258-7258 ext. -7558, artem.arkhipov@unicredit.ru
Gökçe Çelik, Senior CEE Economist (UniCredit Bank, London)
+ 44 207 826-6077, gokce.celik@unicredit.eu
Ariel Chernyy, Economist, Macroeconomic Analysis and Research Russia (UniCredit Russia)
+7 495 258-7258 ext. 7562; ariel.chernyy@unicredit.ru
Hrvoje Dolenec, Chief Economist (Zagrebačka banka)
Published on 13 January 2020 +385 1 6006-678, hrvoje.dolenec@unicreditgroup.zaba.hr
Andrei Florin, PhD, Senior Economist Romania (UniCredit Bank Romania)
+40 21 200-1377, andrei.florin@unicredit.ro
Erik F. Nielsen Dr. Ágnes Halász, Chief Economist, Head of Economics and Strategic Analysis Hungary (UniCredit Hungary)
Group Chief Economist +36 1 301-1907, agnes.halasz@unicreditgroup.hu
(UniCredit Bank, London)
120 London Wall Ľubomír Koršňák, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
UK-London +42 12 4950-2427, lubomir.korsnak@unicreditgroup.sk
EC2Y 5ET Elia Lattuga, Deputy Head of Strategy Research (UniCredit Bank, London)
+44 207 826-1642, elia.lattuga@unicredit.eu
Imprint: Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)
UniCredit Bank AG +43 50505-82712, mauro.giorgiomarrano@unicredit.de
UniCredit Research
Am Eisbach 4 Kristofor Pavlov, Chief Economist (UniCredit Bulbank)
D-80538 Munich +359 2 923-2192, kristofor.pavlov@unicreditgroup.bg
Supplier identification: Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
www.unicreditresearch.eu +420 955 960-716, pavel.sobisek@unicreditgroup.cz
UniCredit Research page 3 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
CEE
An outperformer in testing times
Dan Bucsa, ■ 2020 could prove a difficult year for EM due to weak global trade, a likely slowdown in the
Chief CEE Economist
(UniCredit Bank, London) US, tighter financial conditions in EM and the impact these factors might have on policies and
+44 207 826-7954 macroeconomic imbalances. A recovery is on the cards in 2021.
dan.bucsa@unicredit.eu
■ CEE could be again an outperformer among EM owing to lower reliance on foreign capital
and US demand, as well as better economic policies and the EU anchor.
■ In EU-CEE 1, we expect economic growth to slow to 2.5% in 2020 from 3.6% in 2019,
affected by weaker global trade and a cyclical downturn in the US. Economic growth could
recover to 2.8% in 2021 if global trade rebounds.
■ Growth in the western Balkans will follow the same trajectory as in EU-CEE. We expect rate
cuts in Czechia and Serbia, and rates on hold in all other EU-CEE countries.
■ Growth in Turkey is likely to pick up gradually to around 2% in 2020 and 3% in 2021 but
remain below potential in both years. The CBRT may cut its policy rate to 10% or lower,
keeping the real interest rate close to zero.
■ In Russia, economic growth could remain below 1.5% in 2019-20 if investment under the
national projects program fails to start. We expect the CBR to cut the policy rate to 5.75%
or below in 2020 as inflation remains below the 4% target.
■ The main political risks will be a smaller EU fund allotment to central Europe, thwarted
European integration in the western Balkans and US sanctions on Turkey and, to a lesser
extent, on Russia.
■ We highlight four convergence trades: inflation in EU-CEE and Turkish rates and inflation
(1Q20), Czech and eurozone rates (from 2Q20 onwards), EU-CEE EUR bond yields and
Bunds (throughout 2020), Russian rates and inflation (in the medium term).
2019 – A better-than-expected 2019 turned out to be better than expected for all CEE countries. In EU-CEE, the stronger
year in CEE
resilience stemmed from solid domestic demand, with private consumption and investment
continuing to grow above potential. Exports were a drag in all countries, but those that benefited
from significant investment projects fared better, with Hungary standing out. In the western
Balkans, fiscal easing offset weaker foreign demand, keeping growth close to potential.
As anticipated at the beginning of the year, Russia did not face significant new sanctions.
This ushered in large portfolio inflows and reduced exchange-rate volatility. The CBR cut
rates and financial conditions eased further, with the credit impulse contributing to growth
along with fiscal policy. However, the improvement was cyclical, with structural issues
continuing to drag on potential growth.
Turkey managed to exit recession faster than expected as the country avoided sanctions from
the US due to the purchase of S-400 missiles from Russia and its trade with Iran, a stand-off
with Russia due to the lingering conflict in Idlib (and faced fewer refugees than expected) and
turmoil following the AKP’s loss of large cities in local elections. The benign external
environment helped the government borrow and spend more than expected, with the fiscal
impulse reaching 2.3% of GDP in 2019. In addition, the CBRT was able to halve the policy
rate to 12% without triggering real currency depreciation.
1
EU-CEE comprises Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Slovakia and Slovenia – all CEE countries that are members of the EU.
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CEE Quarterly
2020: A year of stalled reforms in EM…
A more challenging external 2020 may well prove a more difficult ride for EM in general and for CEE in particular. If global
environment for EM in 2020… growth fails to recover and the US economy slows before year-end, as we expect, financial
conditions could tighten in EM even if interest rates remain low in developed markets (DM).
The strategy section of this publication explains how important the US credit cycle is for EM
flows 2 and why this year may not be as benign as 2019.
Unrealized investor optimism towards EM is captured by economic surprises, which have
been negative in EM for most of the past two years (Chart 1). The recent recovery is
explained mostly by China and hopes of a US-China trade agreement.
The imminent phase-one trade agreement between the US and China fails to address tariffs in
manufacturing that are affecting global supply chains and are denting export growth throughout
EM. If global manufacturing and Chinese growth do not recover in 2020, commodity prices
could tank, affecting trade balances and currencies in commodity-exporting EM.
More importantly, external risks are only part of the story. Idiosyncratic risks may well come to
…could enhance idiosyncratic the fore again in 2020. The combination of weak global trade and tighter financial conditions
risks…
will affect economic growth in EM, limiting the capacity of governments to stimulate domestic
demand. As a result, reform momentum could stall in EM, limiting the scope for better growth
ahead. This contrasts with markets’ optimistic view of a recovery in countries such as Brazil,
…and stall reforms
Mexico, India and South Africa.
As recent street protests in South America demonstrate, popular appetite for reforms remains
low and governments will struggle to appease voters concerned with falling living standards.
The likely result will be larger fiscal deficits and borrowing needs that will put additional
pressure on EM currencies already affected by negative terms-of-trade shocks.
Thus, the quality of institutions and democratic processes are unlikely to improve in the
coming years, boding ill for the business environment, for policy predictability, investment
and, ultimately, for potential growth. EU-CEE remains the best EM region according to these
criteria (Chart 2), but it is by no means immune to deterioration. However, pressure from EU
institutions is likely to increase in the coming years, providing the stick (and the EU-fund
carrot) that no other EM region benefits from.
CHART 1: NEGATIVE ECONOMIC SURPRISES IN EM CHART 2: THE QUALITY OF DEMOCRACY IS FALLING IN MOST EM
positive number = actual data Economic surprise index - EM democracy index,
0 = minimum, 2018 2013 2008
release better than expected
Economic surprise index - major economies
60
10 = maximum
Middle East, North Africa
40
CIS, GE, UA, TM
20
Sub-Saharan Africa
0 Asia
-20 Balkans
-40 Latin America
EU-CEE
-60
Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
0 1 2 3 4 5 6 7 8
Source: Bloomberg, Citi, Economist Intelligence Unit, UniCredit Research
2
For details, please see page 17
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CEE outperformance among EM Last year, we predicted correctly that low-yielding CEE would outperform other EM regions 3
could continue in 2020 despite
idiosyncratic risks owing to more-stable economies and stronger resilience to shocks. This story could well
repeat itself in 2020 as domestic risks may prevent larger EM from achieving the growth rates
that markets are hoping for.
All EU-CEE countries to lose This does not mean that CEE is immune to idiosyncratic risks. For EU-CEE, negotiations on a
funds in the 2021-27 EU budget new EU budget are unlikely to yield a better outcome for the Visegrád four, whose nominal
fund allotment will decline. While the other EU-CEE countries will see their nominal
allocations increase, there will be declines across the board in percent of average GDP in
2021-27 4. Cuts in the EU fund allotment will range between 0.2-0.3% of GDP per year in
Romania, Bulgaria and Slovenia and 1.0-1.1% of GDP in Hungary and Poland. The impact on
GDP growth will depend on how countries time EU fund inflows. Thus, active spenders of EU
funds like Hungary could bear the brunt in 2022-25, while the impact will be larger in 2027-28
for late spenders such as Czechia and Romania. The cuts could be even deeper if some net
contributors manage to reduce the size of the EU budget to 1.07% of gross national income
(GNI) and payments to 1.06% of GNI compared to 1.11% of GNI (1.08% of GNI in payments)
proposed by the European Commission and 1.3% of GNI in payments suggested by the
European Parliament.
Risk of limited US sanctions Turkish President Recep Tayyip Erdogan’s determination to install Russian S-400 missiles
on Turkey… may lead to US Congressional sanctions, although US President Donald Trump seems less
keen on punishing the Turkish administration. While sanctions remain a risk, punitive
measures may be confined to certain people and institutions rather than being far reaching
…and of no reforms to cement and a risk to market stability. Needed reforms that would cement the cyclical adjustment in
the cyclical adjustment the C/A deficit may not be implemented. Potential early elections in 2021 would only increase
the focus on short-term fixes.
Declining risk of US sanctions According to the US Congress, Russia could still face sweeping sanctions if there is evidence of
on Russia… interference in the 2020 US elections. This risk might be mitigated by the ever-increasing numbers
and sources of fake social media accounts involved in the US election campaign on all sides.
Reform momentum is stalling and potential growth remains close to 1%, leading to further
divergence from other EM. From a longer-term perspective, the country is in dire need of
…and risk of stalling growth
structural reforms addressing the labor market, the business environment, the judicial system,
healthcare and social security. As the watered-down increase in the retirement age showed,
many of these reforms could be sacrificed if politicians fear the loss of popular support.
Western Balkans need an EU The western Balkans are at risk of stalled convergence to the EU, political turmoil and shifting
accession roadmap to avoid geopolitical allegiances after their European integration process was derailed by France.
economic and political turmoil
The decision not to grant Albania and Northern Macedonia a roadmap to EU accession will
shake up politics in the western Balkans while also weakening reform momentum. Although not
directly targeted by the decision, Serbia has also been affected by stalled European integration,
with political noise increasing in the last quarter of 2019. While countries in the Balkans need
the integration process to resume as soon as possible, other issues facing the EU – among
them the 2021-27 budget and a common defense mechanism – could push this topic further
down the agenda. If this is the case, 2020 could be a lost year for the western Balkans.
In the Balkans, the best solution to re-start the EU accession process would be a rapid
adoption of the seven-stage accession model proposed by the French administration to make
amends for its initial opposition 5.
3
When comparing total returns from investment in local-currency sovereign bonds
4
For details, please see CEE Quarterly – A moment of reckoning, 27 June 2018, pages 17-23.
5
For details, please see The non-paper “Reforming the European Union accession process” from November 2019. The accession stages are 1. rule of law,
fundamental rights, justice and security; 2. education, research and space, youth, culture, sports, environment, transport, telecommunications and energy;
3. employment, social policy, health and consumer protection; competitiveness; 4. economic and financial affairs; 5. internal market, agriculture and fisheries;
6. foreign affairs; and 7. other matters.
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CEE Quarterly
Fulfilling requirements under this scheme would grant gradual access to EU markets and
institutions, while hopefully preventing economic divergence and reducing political uncertainty.
…and of differentiation amid shocks
In EU-CEE, 2020 will further highlight the gap between strong domestic demand and weak
Domestic demand will
remain the biggest growth exports (Chart 3). A dense election cycle is coming to an end and, as a result, the fiscal
driver in EU-CEE impulse could peak in the first half of 2020. Although private consumption has been the
strongest and most stable contributor to economic growth for four years, it has received
additional support from wage and pension increases. Fast income growth will help
households weather external headwinds at the beginning of 2020. Eventually, weaker exports
will affect industrial production and wage bargaining, even after the expected recovery in
global trade at the beginning of 2021 (Chart 4).
CHART 3: GROWTH BELOW POTENTIAL IN 2020… CHART 4: … WITH A SLIGHT RECOVERY IN 2021
yoy (%, pp) Private consumption Public consumption Fixed investment yoy (%, pp) Private consumption Public consumption Fixed investment
Net exports Inventories, error GDP Net exports Inventories, error GDP
Bulgaria Bulgaria
Poland Poland
Hungary Hungary
Serbia Serbia
Croatia Croatia
Romania Romania
Turkey Turkey
Czechia Czechia
Slovenia
Slovenia
Slovakia
Slovakia
Russia
Russia
-2 -1 0 1 2 3 4 5
-2 -1 0 1 2 3 4 5
Source: Eurostat, national statistical offices, UniCredit Research
Labor market tension is easing In fact, labor market tension is already easing in EU-CEE. The manufacturing sector is the
most affected due to slowing exports (Chart 5). Current vacancy levels are still close to all-
time highs, with construction standing out, but the combination of slower wage growth in the
private sector and smaller raises in the public sector is expected to weigh on consumption.
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More-open economies first to The more-open economies such as Czechia, Hungary, Slovakia and Slovenia will be hit first,
slow due to weaker exports…
with domestic demand expected to slow significantly already in 1H20. The disruption in global
supply chains will affect these countries more than the rest of the region, as their exports have
a higher content of imports. Since EU-CEE producers are price takers, higher production
costs could continue to eat into margins and profits, reducing investment. In the four
countries, poor external demand could delay some FDI projects, especially greenfield ones. In
bigger economies such as Poland and Romania, where domestic demand makes a larger
contribution to GDP, the slowdown may be more pronounced in 2H20. However, their
recovery in 2021 is likely to be more muted as well. Finally, Croatia and Bulgaria could be less
affected by the slowdown in eurozone growth than countries in EU-CEE of similar size due to
their weaker integration into eurozone production chains, especially in car manufacturing.
…which will affect investment… Throughout EU-CEE, capex is expected to decelerate in 2020, recovering in 2H21 when global
trade should be in better shape. Moreover, FDI could be dominated by intercompany debt. During
downturns, eurozone companies transfer cheap loans to their subsidiaries in EU-CEE without
charging the country risk, as banks have to do. EU funds will be the main tool to offset this
cyclical slump in private investment, with the end of the current EU budget in 2020 likely to boost
inflows in 2020-21. However, experience from 2012-14 showed that EU-funded investment at the
end of the current EU budget tends to be less efficient and contribute less to potential growth.
Fiscal policy will have little leeway to boost investment in 2020-21. Czechia and Bulgaria are
exceptions in terms of existing fiscal space, though not necessarily when it comes to actual
…due to little scope infrastructure spending. Governments increased public outlays too soon, with fiscal impulses
for fiscal stimulus in 2020-21…
peaking in 2019 (Chart 6). Crowded out by social and wage spending, public investment is
also suffering from misallocation. In the run-up to elections, governments tend to divert funds
from nationally-important infrastructure projects to small projects that become a source for
graft and bribes to local authorities. As a result, the biggest infrastructure investment, namely
the introduction and expansion of 5G networks, is likely to be private as well in 2020-21.
CHART 5: LABOR MARKET SHORTAGES EASING IN EU-CEE CHART 6: FISCAL IMPULSES PEAKED TOO SOON
Companies facing labour shortages, Range (2000-19) fiscal impulse, % of GDP 2019F 2020F 2021F
balance of answers (yes-no), %
4Q19
2.5
80
70 2.0
60 1.5
50
1.0
40
30 0.5
20
0.0
10
0 -0.5
-10 -1.0
Constr
Constr
Constr
Constr
Constr
Constr
Constr
Constr
Ind
Ind
Ind
Ind
Ind
Ind
Ind
Ind
-1.5
BG HR CZ HU PL RO SK SI -2.0
HU RO HR SK SI TR RS PL CZ RU BG
Source: national statistical offices, central banks, AMECO, UniCredit Research
…and also consumption Slower wage growth may impact consumption, since the 2017-19 spending spree was
financed mostly through income growth rather than borrowing. Even though monetary
conditions will remain accommodative, we do not expect lending to accelerate in order to
offset weaker consumption. For the same reason, the absence of significant household
leveraging, the risk of real-estate bubbles popping in EU-CEE is much lower than it was
during the global financial crisis. The only places where house prices adjusted for wage
growth are higher than they were before the global financial crisis are Prague and Budapest,
which are both strong investment markets.
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CEE Quarterly
Western Balkan slowdown Western Balkan countries could be hit harder by external weakness. Lack of access to the
similar to that in EU-CEE
European common market and to steady sources of FDI could lead to choppy growth rates.
Political uncertainty and the cyclical downturn in Europe will remain a drag on growth. Thus,
public infrastructure spending is likely to dominate investment, while households will benefit
from better income growth as governments reverse some of the recent fiscal tightening.
Low growth in Russia without Better insulated from external risks, Russia is struggling to evade the constraints of its low
a boost to investment spending
potential growth. If investment under the national priorities announced by President Vladimir
Putin in 2018 does not start, GDP growth could remain below 1.5% in 2020-21, leading to
further divergence from Europe and other EM. That said, there is scope for better growth
ahead. Russia’s adjustment to previous commodity price shocks, large reserves and a fiscal
breakeven oil price of around USD 45/bbl would allow the government to raise fiscal spending
even if commodity prices fall further from their current levels. Both credit and fiscal impulse
will contribute to growth in 2020 without threatening wider economic imbalances.
Gradual recovery Turkey’s exit from recession may be followed by faster growth rates of 2.2% in 2020 and 3.1%
in Turkish growth
in 2021. However, a return to potential growth of more than 4% per year is unlikely in the
absence of structural reforms. This means that unemployment will continue to rise and the
negative output gap will widen further. As Turkey is over-reliant on fiscal spending and bank
lending, growth is likely to fluctuate with global financial conditions and investor appetite for
lending to emerging markets. While companies rolled over all their long-term liabilities in
2019, potential corrections in credit and equity prices in the US could curb credit flows to
Turkey. Banks rolled over around 60% of their long-term foreign funding in 2019, a signal that
appetite for releveraging is yet to return. Even so, the credit impulse will turn positive, but
could be limited for prudential reasons, with liquidity and delinquency issues yet to peak. At
the same time, the fiscal impulse will fall in 2020-21 compared to 2019.
Peak inflation in 1H20, dovish central banks in 2020-21
Inflation to peak in 1Q20 Headline inflation is expected to peak in 1H20 throughout EU-CEE due to a base effect in fuel
and return thereafter to prices combined with above-target core inflation. The peak will very likely see inflation leave
within target ranges in EU-CEE
target ranges temporarily. However, low imported inflation from the eurozone and the global
slowdown we expect could combine to keep inflation inside target ranges in 2020-21 (Chart 7).
There will be differentiation in disinflation, with Czechia likely to have the lowest inflation rate
among EU-CEE countries outside the eurozone. In Poland and Hungary, disinflation could be
more limited due to a significant fiscal impulse and very loose monetary conditions,
respectively. The outlier is Romania, where inflation could miss the target for three
consecutive years (2019-21) if gas and energy prices are re-liberalized as scheduled.
The NBP, the NBH and the NBR Thus, we expect the NBP, the NBH and the NBR to be on hold throughout 2020-21 (Chart 8),
expected on hold in 2020-21
although monetary conditions in these countries will be significantly different. A very orthodox
approach to monetary policy means that the NBP is likely to pit inflationary risks against lower
growth and external factors, with the result being stable interest rates and a EUR-PLN
exchange rate that will remain close to fair value at around 4.30 for the most part.
The NBH’s preference for loose monetary conditions and the active use of FX swaps to
provide HUF liquidity could translate into very low BUBOR rates, combined with gradual HUF
depreciation throughout 2020-21. The latter may be needed to offset the elimination of the
corporate sector savings surplus due to central bank lending schemes and poor exports,
especially in 2020. The low cost of carry will maintain the HUF’s position as the preferred
short in the region.
The NBR will maintain a combination of negative real interest rates and RON real
appreciation, which bodes ill for disinflation and exports. Due to strong domestic demand and
likely price increases on the horizon, inflation expectations will remain loosely anchored.
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Gradual RON depreciation to the EUR-RON 4.90-5.00 range by 2021 will be insufficient to
offset the loss of external competitiveness, evident especially when adjusting effective
exchange rates with unit labor costs. Adding poor productive investment, especially from
domestic sources, Romania’s exports could remain the weakest in EU-CEE.
Potential rate cuts in Czechia The CNB will start 2020 with a hawkish bias that is likely to wane once inflation begins to fall
if growth and inflation slow from its 1Q20 peak. An outright dovish bias could emerge if exports turn out to be weaker
than in the CNB’s extremely optimistic outlook. If inflation and economic growth slow in line
with our expectations, the proactive CNB Board is likely to cut interest rates already in 2020.
Higher nominal and real interest rates than in the rest of central Europe could help the CZK
outperform its regional peers.
A last cut from the NBS In Serbia, the central bank may cut interest once more, to 2%, and keep the policy rate at that
is possible level in 2020-21. Serbia is a latecomer to the domestic-demand boom in CEE and, as a result,
the output gap remains close to zero and is failing to exert pressure on consumer prices. In
the absence of large supply shocks, inflation may stay below the 3% target in 2020-21 and
the NBS might have to lower its target in the coming years. At the same time, the currency
remains overvalued and vulnerable to volatile capital flows due to the large C/A deficit. If FX-
index lending slows, pressure will rise on the RSD.
The CBR is expected to cut In Russia, inflation is unlikely to return to the 4% target in 2020. With growth close to potential,
the key rate to around 5.75%
in 2020… domestic demand will exert muted pressure on prices. As inflation expectations and the FX
pass-through decline, inflation could struggle to return to target sustainably and the CBR may
have to lower its target in the next two years. Meanwhile, more rate cuts are likely, to at least
5.75% by mid-2020. Further easing would be warranted if the central bank again reassesses
its high estimates of equilibrium rates as risk and potential growth assessments decline. The
RUB is slightly overvalued at the moment and could fluctuate close to fair value in 2020-21.
In Turkey, the CBRT is returning to its near-zero real-interest-rate policy of yesteryear. After a
…and the CBRT could keep the
real interest rate close to zero move above 10% in 1H20, we expect inflation to stabilize in the high single-digits in 2H20-
2021, meaning that the policy rate could be cut to (or slightly below) 10%. Risk appetite for
EM assets and financial conditions in core markets will continue to shape TRY volatility. Thus,
we expect the TRY to weaken faster towards the end of each half of this year. However,
inflation may outpace nominal depreciation in both 2020 and 2021, reducing some of the TRY
undervaluation. Due to the credit-driven growth model and reliance on foreign funding, the
TRY will remain the currency in CEE that is most vulnerable to abrupt changes in risk
appetite, especially if stronger domestic demand drives the C/A into a deficit again.
CHART 7: INFLATION CLOSER TO TARGETS BY 2021 CHART 8: POLICY RATES STABLE OR FALLING IN 2020-21
annual inflation (eop, %) 2019E 2020F 2021F Inflation target policy rates, % 2019E 2020F 2021F
12 15
10
12
8
9
6
4 6
2 3
0
HR SI BH RS SK CZ BG PL HU RU RO TR 0
HU PL CZ RS RO RU TR
Source: statistical offices, central banks, UniCredit Research
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CEE Quarterly
Market outlook: Convergence trades
Having outperformed among EM (again) in 2019, CEE starts 2020 as the low-yielding, ugly
duckling that may still fare better than its higher-paying peers.
Sharp turning points likely in In 1Q20 and beyond, EM bond performance will depend on the evolution of Bund yields,
EM bond performance geopolitical risks, trade negotiations between the US and China and the pace of global
growth6. The combination of these factors is unlikely to lead to a smooth ride, with the
possibility of sharp turning points ahead.
We expect Bund yields to fall this year, mainly due to supply scarcity. EUR spreads could
react differently in EU-CEE, with CZECH, REPHUN and POLAND bonds outperforming,
helped by negative net supply and BGARIA supported also by ERM II entry. Meanwhile,
spreads could widen slightly in the case of CROATI and ROMANI bonds.
Assuming a de-escalation of the standoff between the US and Iran, risk appetite could
recover even if the tit-for-that continues, as long as oil production is not affected.
Trade negotiations between the US and China signal that the likelihood of an escalation of
tariffs has reduced. At the same time, a significant unwinding of existing tariffs that affect
manufacturing and global supply chains does not look likely in 2020. If markets consider the
upcoming phase-one deal between the US and China as the beginning of a thaw, export-
dependent EUR and EU-CEE currencies could gain against the USD.
In the absence of a meaningful rollback of tariffs, a sentiment-driven recovery in global trade
may not last. Adding our expectations of weaker US growth, especially in 2H20, global trade
and growth could remain a risk for EM financial assets this year.
Turning to CEE, we see several convergence trades for 2020:
1. Inflation convergence in EU-CEE
Inflation convergence in EU- In 1Q20, inflation will leave target ranges in Hungary and Poland, having done so already in
CEE should affect HGBs more
Czechia and Romania. In terms of real yields in 1Q20, the best insulated EU-CEE bonds are
than ROMGBs and POLGBs
ROMGBs, whose real 10Y yields remain positive and significantly higher than their regional
peers due to fiscal risks. However, bad news could be limited until the end of March: there are
no rating updates for Romania and the European Commission assessment does not come
until April. The biggest risk to ROMGBs remains potential RON depreciation if the NBR allows
EUR-RON to move to a 4.80-90 range this quarter, as we expect. However, ROMGBs are
also the most attractive local-currency bonds when FX-hedged.
Among the other local-currency bonds, POLGBs retain the strong support of local banks and
will be helped by low issuance requirements. Higher inflation could lead to a bear-flattening of
the curve. Given that POLGBs are exempt from the bank tax, swaps are likely to correct more
than yields.
At the other end of the spectrum, HGBs are the most expensive bonds in the region by all
metrics bar FX-hedged. The lure of a low and stable cost of hedging explains the nine
consecutive quarters of foreign purchases that ended with an outflow in 4Q19. USD-based
investors will continue to prefer this trade, while EUR-based investors may return to POLGBs
or, if the Romanian fiscal outlook improves, ROMGBs. A steeper curve may be the short-term
effect of the inflation spike.
6
For UniCredit’s view on these issues (except the standoff between the US and Iran), please see the UniCredit Macro & Markets 2020-21 Outlook published on
21 November 2019.
UniCredit Research page 11 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
Even if the pace of disinflation differs in 2H20 and 2021, EU-CEE inflation rates are likely to
remain in a tighter range than in 2016-19.
2. Upcoming convergence of Czech and eurozone rates
Positioning for lower CZK rates The inflation differential between Czechia and the eurozone is currently at its highest level
should start in 1Q20
since the global financial crisis. We believe that this spread will start narrowing from 2Q20
onwards once external risks to growth start to overwhelm domestic inflationary pressure
(Chart 9). Thus, the CZGB spread to Bunds is likely to narrow the once the risk of monetary
tightening is removed. In the medium term, long-term yields should fall below those in
Hungary and Poland due to Czechia’s lower potential growth and inflation target and to better-
anchored inflation expectations.
If the CNB does not hike in 1Q20, as we expect, and then turns gradually more dovish, the
1y1y forward swap rate – the market’s preferred measure of central-bank hawkishness –
should head south as well. Positioning for lower swap rates and bond yields is likely to start
already this quarter.
3. Further convergence of Czech, Hungarian and Polish EUR long-term bond yields
with Bunds
Lower yields for CZECH, The main reasons for flatter EUR curves are negative supply of CZECH, REPHUN and
REPHUN and POLAND
EUR bonds POLAND bonds, as well as our benign outlook for Bund yields.
4. Russia’s convergence to a lower-inflation, lower-rates equilibrium
OFZ rally threatened by RUB
OFZs have been among the best performers in EM in 2019, helped in part by RUB appreciation.
overvaluation in 1Q20… Investors are starting to wonder whether the rally has legs, since the CBR has probably made
most of its rate cuts. We expect 50bp in additional cuts, while the FRA curve is currently pricing
in less than one cut in the next six months. This is very likely due to the reluctance of local banks
…but has legs in the to join the bond rally. In our view, Russia is moving to a lower-inflation, lower-rate equilibrium
medium term
that will require the CBR to cut its inflation target in the coming years.
In 1Q20, the market may eliminate some of the RUB’s current overvaluation and this could
reduce long bond positions, offering a good re-entry point.
Convergence of the monetary policy rate and inflation in Turkey
Low real rates a threat for the TRY 2019 was a good year for the CBRT, which managed to halve its policy rate to 12%. We
expect further cuts to 10% this year, bringing the real policy rate close to zero. This has been
the CBRT’s policy in the past and the effects could be similar this time around: the TRY may
depreciate (Chart 10), especially if risk appetite for EM falls. We expect nominal depreciation
against the USD to remain slightly less than carry gains in 2020. Given our global growth
outlook, risks of faster depreciation are higher towards the end of each half of this year.
There are also pockets of divergence that may last into 2020:
ROMANI EUR yields to remain 1. ROMANI yields will remain consistent with a below-investment-grade rating. This is
well above regional peers
already the case and a decisive rally would need fiscal consolidation and a lower risk
of rating downgrades. Given current rating levels, a downgrade to junk is unlikely
before S&P’s rating review scheduled on 4 December. The country’s large net bond
supply – which is estimated at EUR 2.5bn in 2020, most of which likely to be issued
in the first quarter – could also prevent a significant rally.
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CEE Quarterly
RON overvaluation: 2. The RON will remain overvalued and the HUF undervalued. For both currencies, the
A trade in case of fiscal slippage
reason is the monetary policy set-up, which is based on low real interest rates.
These are doubled by FX interventions in Romania.
If the NBR disagrees with government policy (e.g. if the government implements a
40% increase in pensions this year), it may let the RON depreciate more to show
that market pressure can build up. This would be an extraordinary behavior for the
NBR in the run-up to elections, but these are extraordinary times.
If risk appetite improves and capital flows recover, the HUF might appreciate. This
HUF undervaluation a boon
for range trades could lead to range trades in EUR-HUF, with highs likely to move above 335 this
year and levels below 329 providing good entry points into long positions.
CHART 9: DIVERGENCE IN CZECH RATES
FROM EUROZONE RATES SHOULD END CHART 10: THE TRY NEEDS SUPPORT FROM REAL RATES
10Y swap spread CZK - EUR 10Y swap spread CZK - EUR
% %
Inflation spread Czechia vs eurozone Inflation spread Czechia vs eurozone
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
-0.5 -0.5
-1.0 -1.0
-1.5 -1.5
Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20
Source: statistical offices, central banks, Bloomberg, UniCredit Research
UniCredit Research page 13 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
OUR GLOBAL FORECAST
Exchange rate
GDP growth, % CPI (Avg), % Policy rate* (%) 10Y bond yield (EoP), % LC vs. USD
2019E 2020F 2021F 2019E 2020F 2021F 2019 2020F 2021F 2019 2020F 2021F 2019 2020F 2021F
Eurozone 1.2 0.8 1.0 1.2 1.0 1.1 -0.50 -0.50 -0.50 1.12 1.16 1.18
Germany 0.6** 0.7** 0.8** 1.4 1.5 1.5 -0.19 -0.50 0.20
France 1.3 1.0 1.1 1.1 1.1 1.2
Italy 0.2 0.2 0.5 0.6 0.7 0.8 1.41 1.00 1.70
UK 1.3 0.9 0.9 1.8 1.3 1.5 0.75 0.00 0.00 1.32 1.35 1.40
USA 2.3 1.1 0.9 1.8 1.7 1.5 1.75 0.75 0.75 1.92 1.50 2.50
Oil price, USD/bbl - - - - - - - - - - - - 64 58 55
*Deposit rate for ECB; ** Non-wda figures. Adjusted for working days: 0.6% (2019), 0.3% (2020) and 0.8% (2021) Source: Bloomberg, UniCredit Research
THE OUTLOOK AT A GLANCE
Real GDP CPI C/A balance
(% change) 2018 2019E 2020F 2021F (% change) 2018 2019E 2020F 2021F (% GDP) 2018 2019E 2020F 2021F
EU-CEE 4.3 3.6 2.5 2.7 EU-CEE 1.9 3.3 2.8 3.0 EU-CEE -0.8 -0.3 -0.6 -0.3
Bulgaria 3.1 3.7 3.0 3.1 Bulgaria 2.7 3.8 2.6 2.8 Bulgaria 5.4 6.3 5.8 5.3
Czechia 2.9 2.4 1.9 2.1 Czechia 2.0 3.2 2.3 2.1 Czechia 0.3 1.0 1.4 1.5
Hungary 5.1 4.9 2.9 3.0 Hungary 2.7 3.9 3.1 3.3 Hungary -0.5 -0.9 -1.0 -0.2
Poland 5.2 4.0 3.0 3.3 Poland 1.1 3.4 2.7 3.1 Poland -1.0 0.2 -0.7 -0.3
Romania 4.0 3.9 2.3 2.1 Romania 3.3 3.9 4.0 4.3 Romania -4.6 -5.0 -4.6 -4.2
Croatia 2.7 2.9 2.4 2.4 Croatia 0.8 1.7 1.5 2.0 Croatia 1.9 1.2 0.8 0.5
Russia 2.3 1.1 1.1 1.4 Russia 4.3 3.0 3.5 4.0 Russia 6.9 5.0 4.1 4.1
Serbia 4.4 4.0 2.7 3.0 Serbia 2.0 1.9 2.1 2.1 Serbia -5.2 -6.5 -6.9 -6.5
Turkey 2.8 0.3 2.2 3.1 Turkey 20.3 11.8 9.5 8.9 Turkey -3.5 0.2 -1.8 -2.4
Extended basic External debt General gov’t
balance (% GDP) 2018 2019E 2020F 2021F (% GDP) 2018 2019E 2020F 2021F balance (% GDP) 2018 2019E 2020F 2021F
EU-CEE 2.8 2.8 2.4 2.8 EU-CEE 70.9 67.0 63.8 60.6 EU-CEE -0.6 -1.1 -1.5 -1.7
Bulgaria 6.8 8.8 8.4 8.3 Bulgaria 59.1 56.1 53.9 51.5 Bulgaria 1.8 1.1 0.4 -0.1
Czechia 2.3 2.5 3.0 3.2 Czechia 81.6 79.8 78.0 76.4 Czechia 1.1 0.0 -0.7 -1.2
Hungary 4.2 1.9 3.1 3.8 Hungary 80.8 76.1 71.0 64.8 Hungary -2.3 -1.8 -1.3 -2.0
Poland 3.6 4.1 2.7 3.2 Poland 63.2 56.9 51.6 47.5 Poland -0.2 -0.7 -1.4 -1.5
Romania -1.3 -1.5 -2.0 -1.4 Romania 48.6 49.2 52.0 52.7 Romania -3.0 -4.3 -4.0 -4.0
Croatia 4.6 5.0 5.0 5.2 Croatia 82.7 81.9 80.7 79.3 Croatia 0.2 -0.3 -0.2 -0.3
Russia 5.5 3.5 2.6 2.6 Russia 28.2 27.5 26.8 26.9 Russia 2.6 1.4 0.5 0.4
Serbia 2.3 1.2 0.0 0.1 Serbia 62.6 60.5 58.4 56.5 Serbia 0.6 0.2 -0.5 -0.5
Turkey -2.3 1.0 -0.8 -1.3 Turkey 55.9 57.8 56.7 55.4 Turkey -3.5 -5.5 -5.1 -4.6
Gov’t debt Policy rate FX vs. EUR
(% GDP) 2018 2019E 2020F 2021F (%) 2018 2019 2020F 2021F (EoP) 2018 2019 2020F 2021F
EU-CEE 46.7 45.1 44.2 43.6 EU-CEE EU-CEE
Bulgaria 21.8 20.5 20.2 21.7 Bulgaria - - - - Bulgaria 1.96 1.96 1.96 1.96
Czechia 32.6 30.8 30.1 30.1 Czechia 1.75 2.00 1.75 1.50 Czechia 25.7 25.4 25.2 25.0
Hungary 68.5 67.7 66.2 65.8 Hungary 0.90 0.90 0.90 0.90 Hungary 321.5 330.5 335.0 340.0
Poland 48.5 46.0 44.1 42.6 Poland 1.50 1.50 1.50 1.50 Poland 4.3 4.3 4.3 4.3
Romania 35.0 35.4 37.6 39.6 Romania 2.50 2.50 2.50 2.50 Romania 4.66 4.78 4.85 4.95
Croatia 74.7 72.2 69.7 67.2 Croatia - - - -I Croatia 7.42 7.45 7.45 7.45
Russia 12.1 12.3 13.7 14.5 Russia 7.75 6.25 5.75 5.75 Russia 79.5 68.9 79.4 83.1
Serbia 54.5 52.0 49.6 47.6 Serbia 3.00 2.25 2.00 2.00 Serbia 118.2 117.6 118.2 118.7
Turkey 30.4 31.5 32.7 33.6 Turkey 24.00 12.00 10.00 10.00 Turkey 6.07 6.67 7.45 7.95
Source: National statistical agencies, central banks, UniCredit Research
UniCredit Research page 14 See last pages for disclaimer.January 2020 CEE Macro & Strategy Research
CEE Quarterly
EM VULNERABILITY HEATMAP
BG CZ HR HU PL RO RS RU SK TR UA MX BR CL SA ID IN CN AG
External Liquidity
Current account (% of GDP) 8.5 0.5 0.6 -1.1 -0.1 -5.0 -6.4 5.8 -3.5 0.7 -2.5 -0.4 -2.6 -3.6 -3.3 -2.9 -2.0 1.4 -2.6
Extended Basic Balance (% of GDP) 10.9 2.3 2.5 4.1 3.5 -1.2 2.2 5.9 1.5 1.8 -0.7 1.5 -0.4 -2.4 -1.3 -1.3 -0.8 1.8 -2.5
FX Reserves coverage (months of
imports) 8.1 7.8 8.2 2.6 4.4 4.3 6.5 14.4 - 4.2 3.3 4.3 16.7 5.5 5.6 6.8 7.5 15.2 8.4
External Debt (excl.ICL, % of GDP)* 34.9 80.0 72.8 55.3 44.3 35.6 63.5 19.8 92.0 59.1 82.3 36.2 65.0 68.5 51.5 36.1 20.3 14.6 53.1
Short-term debt (% of GDP) 13.9 45.6 35.4 9.2 8.6 13.3 3.6 3.7 43.8 15.9 11.8 3.9 4.2 7.9 10.6 4.5 7.8 8.9 12.2
REER (Index, 2010=100) 102.3 98.1 95.6 85.9 90.5 95.9 123.1 85.5 - 64.0 102.3 84.2 111.1 82.0 85.3 92.0 107.8 120.7 -
Domestic Finances
Corporate debt (% of GDP) 47.8 52.2 58.4 57.3 44.8 38.7 43.6 55.0 54.5 93.2 60.5 37.8 42.3 81.1 58.8 36.4 44.4 154.5 16.8
Household Debt (% of GDP) 20.1 34.3 34.6 20.5 35.4 19.4 20.4 15.8 45.2 13.9 5.7 16.3 44.8 36.5 34.0 16.4 12.0 54.6 4.9
Nonresident holdings of gov.debt (% total) 1.1 41.7 - 22.4 23.5 19.0 30.1 39.4 51.3 10.7 - 28.4 12.9 - 36.9 37.7 - 8.4 -
Banking System
Credit Impulse (% of GDP) 0.1 -1.0 2.5 0.9 0.1 0.2 1.9 3.0 -0.7 -4.4 -11.9 -0.9 7.3 1.2 -0.1 -0.3 -0.8 1.1 -0.6
Loans/deposit ratio (%) 72.7 69.3 79.1 76.3 92.3 98.0 92.2 99.9 103.0 105.9 173.0 104.0 98.3 109.4 105.2 103.0 112.6 74.4 152.1
NPL (% of total loans) 7.3 2.6 7.6 2.0 4.0 4.5 4.6 10.1 2.8 5.2 48.9 2.1 3.0 1.9 3.7 2.7 9.5 1.8 4.9
Domestic Banks CAR (%) 21.0 18.8 22.7 17.9 18.4 19.7 23.6 12.2 18.3 18.5 18.4 15.7 17.8 13.3 16.8 23.3 12.9 14.2 16.3
Domestic Banks RoE (%) 13.2 19.0 10.4 17.6 7.6 9.9 10.5 13.0 9.8 11.7 42.5 20.9 15.2 15.5 19.2 14.4 -0.2 11.7 -
*External debt incl. ICL for CZ, RS, TR, MX, CL and SA Source: Haver, Bloomberg, National Statistics Offices, Central Banks, IMF, UniCredit Research
Legend
Low vulnerability
Moderate vulnerability
Significant vulnerability
High vulnerability
UniCredit Research page 15 See last pages for disclaimer.January 2020 CEE Macro & Strategy Research
CEE Quarterly
EM VULNERABILITY HEATMAP (CONTINUED)
BG CZ HR HU PL RO RS RU SK TR UA MX BR CL SA ID IN CN AG
Policy
Policy Rate, nominal (%) - 2.00 - 0.90 1.50 2.50 2.25 6.25 0.00 12.00 15.50 7.50 5.00 1.75 6.50 5.00 5.15 4.35 63.00
Real policy rate (%) - -1.1 - -2.4 -1.8 -1.2 0.8 2.9 -3.0 0.6 9.9 4.4 1.7 -0.9 2.8 1.4 -0.3 -3.6 7.2
Real Money market rate (%) - -0.9 -0.5 -3.1 -1.6 -0.9 0.2 2.9 -3.4 0.5 8.3 4.5 -0.3 -3.0 2.7 1.9 0.3 0.1 -4.6
Headline inflation (% yoy) 3.0 3.1 0.7 3.4 3.4 3.8 1.4 3.5 3.0 11.3 5.1 3.0 3.3 2.7 3.6 3.6 5.4 3.7 52.1
Core Inflation (% yoy) 1.9 2.3 1.3 3.6 3.2 3.5 1.2 3.5 2.7 9.6 4.8 3.7 2.8 2.5 3.9 3.6 3.8 1.6 55.2
GG Fiscal balance (% of GDP) -1.1 0.7 0.3 -1.6 -0.1 -4.3 0.4 3.0 -1.0 -2.6 -1.9 -1.4 -6.4 -2.2 -5.8 -2.0 -3.6 -4.8 -3.7
GG Primary balance (% of GDP) -0.5 0.7 2.8 0.8 1.2 -3.0 2.6 3.5 -0.1 -0.3 - 1.3 1.3 -1.3 -1.9 -0.3 -0.5 -3.8 -
Government Debt (% of GDP) 20.1 33.1 76.1 66.5 46.5 35.6 52.6 12.4 48.4 32.1 62.0 39.4 77.7 35.7 61.5 35.5 46.3 50.6 59.7
Markets
Local Debt Spread (10Y, bp)** 55.9 28.7 96.8 67.1 43.2 162.8 148.7 121.0 51.8 418.8 429.3 132.2 168.2 66.1 266.1 140.0 124.9 36.6 1818.1
Local Currency Curve (5Y, %)*** -0.1 1.3 0.8 1.1 1.9 3.9 0.0 6.0 -0.2 12.1 5.2 6.8 9.1 2.4 8.0 6.4 6.6 2.9 47.6
Local currency bond spread (2s10s)**** 53.8 -0.5 41.1 177.0 67.9 73.2 72.5 72.0 76.5 37.0 262.4 9.2 195.3 272.0 200.6 103.5 34.3 63.7 -4805.1
CDS (5Y, bp) 59 40 70 75 61 78 87 60 37 285 378 79 100 44 161 65 71 34 3521
FX 3m implied volatility (%) - 3.1 4.0 4.8 4.0 3.2 - 8.5 - 11.5 - 7.6 10.9 12.1 14.0 5.7 5.7 4.5 13.4
Structural*****
IBRD Doing Business 61 41 51 52 40 52 44 28 45 33 64 60 124 59 84 73 63 31 126
WEF Competitiveness Ranking 49 32 63 47 37 51 72 43 42 61 85 48 71 33 60 50 68 28 83
Unemployment (%) 4.2 2.2 6.1 3.5 3.1 5.3 10.0 4.6 5.9 13.6 8.1 3.7 11.6 7.0 29.1 5.3 8.5 5.1 9.9
**Spread between 10Y EUR government bond yields and the corresponding German government bond yields for BG, HR, HU, PL, RO. For CZ, the spread refers to the 5Y yield. For the other countries, the spread is computed with respect to US
government bond yields; ***Data for UA refer to the generic USD bond. Data for HR refer to the 4Y bond; ****Data for UA refer to the generic USD bond. Data for CL refer SA to the spread between 8Y and 2Y bond and 9Y and 2Y bond;
respectively. Data for HU refer to spread between 10Y and 3Y bond; *****IBRD and WEF indicators for 2019;
Source: Haver, Bloomberg, National Statistics Offices, Central Banks, IMF, UniCredit Research
Legend
Low vulnerability
Moderate vulnerability
Significant vulnerability
High vulnerability
UniCredit Research page 16 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
CEE Strategy: Dancing to the tune
of the US credit cycle
Elia Lattuga ■ The performance of EM bonds was very positive in 2019, both across geographies and
Co- Head of Strategy Research,
Cross Asset Strategist throughout the rating spectrum. Hard-currency denominated bonds outperformed thanks to
(UniCredit Bank, London) the UST rally. Local-currency-denominated bonds posted solid returns.
+44 207 826-1642
elia.lattuga@unicredit.eu ■ Yield hunting will continue in 2020, and we believe that risk-free yields will again move
south. However, the deterioration of global growth increases the odds of a sharp sell-off of
the riskiest segments of the market and/or those most correlated to the US credit cycle.
Solid performance in 2019 The performance of emerging-market bonds proved very solid in 2019. Risk-free rates
moved lower and, in spite of some short-lived tension, credit spreads tightened on aggregate.
Hard-currency bonds delivered double-digit total returns, 4-7pp in excess of US Treasuries.
The performance of local-currency bonds was more mixed, with returns ranging from 6% in
Asia to 14% in EMEA. With respect to ratings, Baa and Caa outperformed. Hence, total
returns did not necessarily increase with credit risk (proxied by rating buckets) and did not
follow the typical risk-on script. Performance was quite diverse, with respect to both country
and duration. Idiosynchratic factors and global monetary policy trends were the key drivers
in 2019 and these will remain relevant in 2020.
Expectations for 2020 are high. Judging by 1Q returns, the last four years have started very
well for EM bonds, with the exception of 2018, when rising UST yields were a strong
headwind. With US-China trade tensions subsiding and business-confidence indicators
showing signs of stabilization, the short-term picture looks positive. But will demand hold up
strong throughout the year?
The macroeconomic and market landscape in 2020 will, in our view, be characterized by a
loss of momentum in global growth, a shallow recession in the US (2H20) and aggressive
action by the Fed (we expect four 25bp cuts throughout the year). We expect market
sentiment to deteriorate as US growth slows down, and we forecast large corrections in equity
markets ahead of the US recession. This scenario envisages rising risk aversion and spillover
effects from US equities and HY onto global risky assets.
The risks arising from The weakening growth outlook in the US seems set to expose the risk characterizing the US
deterioration in US growth
credit market, especially when it comes to non-financial HY debt. Credit fundamentals in this
segment have been deteriorating over the past few years, with net debt rising sharply and
profit margins exhibiting a downward trend.
SOLID PERFORMANCE: TOTAL RETURNS GROWTH PROSPECTS: OECD LEADING INDICATORS
2019 2018 2017 2016 2015
40% US EU China
106
30%
104
20%
102
10%
100
0%
98
-10%
96
-20%
-30% 94
LatAm
EMEA
LatAm
EMEA
Ba
Asia
Asia
A
B
Caa
7-10 Year
Baa
1-3 Year
92
Oct-06
Apr-10
Oct-13
Apr-17
Aug-05
May-07
Dec-07
Jul-08
Sep-09
Nov-10
Aug-12
May-14
Dec-14
Jul-15
Sep-16
Nov-17
Aug-19
Jan-05
Mar-06
Feb-09
Jun-11
Jan-12
Mar-13
Feb-16
Jun-18
Jan-19
LC HC-USD HC-USD HC-USD
Source: Bloomberg, OECD, UniCredit Research
UniCredit Research page 17 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
The risk of a sharp widening in spreads appears material in a scenario marked by zero growth.
Crossover portfolios would contribute to positive correlations between US HY, global equities and
lower-rated EM bonds. Meanwhile, falling risk-free yields and abundant central-bank liquidity in
global markets would be a tailwind for fixed-income instruments. Moreover, deteriorating US growth
and rate cuts by the Fed also limit the risks posed by an appreciation of the US dollar. Hence,
barring too deep or prolonged a deterioration in risk appetite, EM hard-currency denominated bonds
may continue to benefit from the hunt for yield. However, the allocation across the curve, across
countries and ratings will have to factor in easy central bank against a deteriorating growth outlook.
Two additional risks cloud the horizon: 1. Idyosyncratic risks might result from countries falling short
of expectations on the convergence process and planned reforms and/or failing to improve their
economic/fiscal policies – potentially paving the way to sovereign rating downgrades;
2. Global commodity demand seems set to slow down and persistently low commodity prices will
affect commodity producers that fail to adjust to the new reality. LatAm appears especially exposed
to this risk, but within EMEA, South Africa, Turkey and Romania could be affected.
In order to explore the extent to which EM bonds might be inflenced by global developments,
Tables 1 and 2 show the beta in daily returns between selected EM bond benchmarks and
three exogenous variables: USTs, US HY credit and the S&P 500. The betas were computed
over samples including the largest drawdowns in HY credit and equities and the large UST
rallies of the 2010-19 period.
TABLE 1: SPILLOVERS AT TIMES OF LOSSES FOR US HY AND EQUITIES AND GAINS FOR UST – BY GEOGRAPHY
LC HC-USD
LatAm Asia EMEA LatAm Asia EMEA
S&P500 Jul-11-Aug-11 0.0 0.0 0.0 0.1 0.0 0.0
Aug-15-Sep-15 0.1 0.0 0.0 0.1 0.0 0.0
Dec-15-Feb-16 0.4 0.1 0.1 0.2 0.0 0.1
Jan-18-Apr-18 0.2 0.1 0.1 0.1 0.0 0.0
Oct-18-Dec-18 0.1 0.0 0.1 0.1 0.0 0.0
US HY Sep-18-Dec-18 0.7 0.2 0.7 0.6 0.1 0.4
Sep-14-Dec-14 1.0 0.2 0.4 0.7 0.1 0.5
Jun-15-Feb-16 1.1 0.3 0.3 0.7 0.1 0.3
Jul-11-Oct-11 0.9 0.2 0.9 0.6 0.3 0.5
UST 10Y Mar-10-Oct-10 -0.5 -0.2 -0.6 0.2 0.0 0.0
Feb-11-Sep-11 -0.5 -0.1 -0.9 0.1 0.1 0.0
Nov-15-Jul-16 -1.0 -0.1 -0.4 -0.3 0.3 -0.1
Oct-18-Dec-18 -0.4 -0.1 -0.1 0.0 0.3 0.0
TABLE 2: SPILLOVERS AT TIMES OF LOSSES FOR US HY AND EQUITIES AND GAINS FOR UST – BY RATING AND DURATION
HC-USD HC-USD
A Baa Ba B Caa 1-3 Year 7-10 Year
S&P500 Jul-11-Aug-11 0.0 0.0 0.0 0.2 -0.2 0.0 0.0
Aug-15-Sep-15 0.0 0.0 0.1 0.1 0.2 0.0 0.1
Dec-15-Feb-16 0.0 0.1 0.1 0.1 0.3 0.0 0.1
Jan-18-Apr-18 0.0 0.0 0.0 0.1 0.0 0.0 0.0
Oct-18-Dec-18 0.0 0.0 0.0 0.1 0.0 0.0 0.0
US HY Sep-18-Dec-18 0.1 0.3 0.4 0.8 0.4 0.1 0.4
Sep-14-Dec-14 0.0 0.4 0.6 0.6 2.5 0.3 0.5
Jun-15-Feb-16 0.0 0.4 0.5 0.5 1.2 0.1 0.4
Jul-11-Oct-11 0.3 0.4 0.4 0.9 0.8 0.2 0.5
UST 10Y Mar-10-Oct-10 0.7 0.1 0.0 0.0 0.0 0.0 0.1
Apr-11-Sep-11 0.7 0.2 0.0 -0.3 -0.5 0.0 0.1
Jan-16-Jul-16 0.3 0.0 -0.2 -0.3 -0.7 0.0 0.0
Oct-18-Sep-19 0.4 0.2 0.0 -0.4 -0.1 0.0 0.1
Source: Bloomberg, UniCredit Research
UniCredit Research page 18 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
EM bonds reactions to past As mentioned above, we expect a sharp slowdown in the US economy to trigger sizable
episodes of…
repercussions for global equities. Tables 1 and 2 show what a loss for the S&P 500 could mean
for EM bonds. Across both local and hard-currency denominated bonds, the LatAm region has
Falling US equity prices,
historically been most exposed to swings in US equities. Hard-currency bonds are, however,
less affected overall (as the risk-free component lowers the correlation in general). The level of
duration did not affect performance much in the chosen samples, while bonds with lower ratings
generally displayed higher responsiveness and higher losses when the S&P 500 index fell.
Losses on US HY credit Equities are a good barometer of market sentiment, but yield hunting is also a potential key
driver of demand for EM. Within fixed income, we have run a similar analysis with respect to
US HY and UST. The beta between US HY and EM bond returns (during HY bear markets)
are particularly high for local and hard-currency exposure especially for LatAm. The presence
of crossover investors and the abundance of low-rated bonds in the LatAm region are behind
this. Betas are lower but still positive for the EMEA region, while Asia is largely unaffected by
US HY losses when it comes to hard-currency paper.
Correlations are a tad higher when it comes to bonds denominated in local currencies, and
still more significant for LatAm. Unsurprisingly, the lower-rated segments of EM bond markets
feel the spillovers from US HY more. B and Caa rated bonds display higher betas and losses
across considere episodes are sometimes larger than those in US HY.
Rallying UST bonds The impact of UST movement on EM bonds depends largely on the duration of the chosen
segment. The overall impact is averaged out when looking at diversified benchmarks.
Higher-rated EM bonds are more correlated to developments in risk free assets, and their
spread component is less sizable and less volatile. Local currency bonds tend to display a
negative correlation with USTs in the chosen sample. Note also that, when USTs record
sharp losses, long duration and LatAm (hard-currency) bonds suffer more. A stronger dollar
could be adding to the losses during such episodes.
All in all, LatAm bonds both in hard and especially in local currency are more exposed to
losses in global equities and US HY and to a deterioration of risk appetite in general.
Long-duration bonds can benefit from falling UST yields, however, only on relatively
high-rated exposures. Bonds in EMEA seem well positioned to get the benefit of a fixed-
income-friendly market environment, and should see limited spillovers from weakening
US growth.
PORTFOLIO FLOWS INTO EM (WEEKLY FLOWS, USD BN) FLOWS BY GEOGRAPHY (MONTHLY FLOWS, USD BN)
2015 2016 2017 2018 2019 Asia LatAm EMEA
120 80
100
60
80
40
60
20
40
0
20
0 -20
-20 -40
0 10 20 30 40 50 60 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19
Source: IIF, Bloomberg, UniCredit Research
UniCredit Research page 19 See last pages for disclaimer.January 2020 January 2020 CEE Macro & Strategy Research
CEE Quarterly
Solid flows into EM EM attracted solid portfolio flows in 2019, but most of the buildup in positioning happened
during the first and last quarters of the year. In the first part of the year, the pace of inflows
into EM bond and equity portfolios was close to its highest level from the past ten years,
according to IIF data. Inflows slowed down by the middle of the year and, to rise again in 4Q.
Overal inflows remained above the average over the past ten years. Most of the swings in
flows came from equity funds, for which the first part of the year was exceptional. Over half of
the total inflows for the year were directed to emerging Asia, while the rest was split nearly
evenly between EMEA and LatAm. Net flows for equity portfolios were flat at best across all
regions except Asia. Bonds attracted better inflows across the board. Inflows into Asia will
likely continue over the coming months, barring a sharp deterioration in China’s growth
prospects. With respect to bond funds, given the rating distribution and correlation to HY
developments in the US, we believe that inflows into LatAm might remain subdued over the
next few quarters. Emerging Europe could benefit somewhat from some portfolio reallocation
in the region on the back of the ECB’s QE. Indeed, the region could still offer some pick-up
compared to most EGB issuers, at the price, however, of lower liquidity and a lack of direct
support from ECB purchases. As we have highlighted in the past (see CEE quarterly 4Q19 –
Qualitative Easing), the first round of QE by the ECB triggered large outflows that mostly
benefitted USTs, Gilts and JGBs, at the time offering a sizable yield pick-up and/or
comparable liquidity compared to EGBs. The yield advantage is no longer present, and such
flows might be directed elsewhere.
EUR BOND YIELDS AND EGBS LOCAL CURRENCY BOND RETURNS AND FX VOLATILITY
5Y yield 5Y EGBs' yield
3.5
Yield Return
20
TU
3.0 18
16
Avg yield / 3M total return
2.5
14
12
2.0
10
1.5 8
SE
6
1.0
4
IT
HR GR
2
0.5
RU
RO
0
0.0 FR BU -2
HU
CZ PO SP PT -4
SL SK
-0.5 GE BE 0 2 4 6 8 10 12 14 16
Realized vola FX (past 3M)
-1.0
AAA AA A BBB BB B CCC
Source: Bloomberg, UniCredit Research
From issuance to heading costs Easy financing conditions on the back of accommodative central banks in major markets and
solid inflows in bond portfolios created the conditions for a step-up in supply from EM issuers
in 2019. After the sharp slowdown in 3Q and 4Q18, issuance was sustained throughout 2019.
This was the case for both hard currency and local currency exposure, with the bulk of EM
supply coming from Asia and being well digested. Indeed, performance remained solid. In
emerging Europe, supply was rather scarce in local currency, while it topped the past two
years in hard currency. EUR supply more broadly was very strong in 2019, with reverse-
yankees playing a key role in corporate sector issuance (and accounting for roughly 30% of
total IG corporate issuance in EUR).
Issuance of reverse yankee bonds in the EUR market was supported by the very tight credit
spreads prevailing in the euro area. The abundance of supply, however, did not trigger large
moves in the EUR-USD cross currency basis swap, possibly because hedging activity was
more muted or because the market was more liquid than in the past. On a 5Y tenor, the basis is
in the ballpark of -15bp. This is relatively high (close to zero) compared to the recent past, and
thus the basis is probably less of a primary driver the choice of whether to fund in EUR or USD.
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